What is the value of the firm?
The value of the firm can be calculated through the use of the formula:
Value of the Firm = Free Cash Flow Year 1 / (WACC – Growth Rate) (Deegan, 2013)
From the information provided:
Value of Astro Pharmaceutical Corporation = $2,000,000 * (1 + 6%) / (10% - 6%) =
$2,120,000 / 4% = $53,000,000
What is the market value of the firm’s equity?
We have not been provided any details regarding the market value of debt, the assumption is that the book value of debt will be the market value of debt (Marchica and Mura, 2010). The formula of the market value of equity is as shown:
Market Value of Astro Pharmaceutical Corporation’s Equity = $53,000,000 - $500,000 =$52,500,000
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What is the firm’s MVA?
The MVA can be calculated through the use of the formula:
MVA = Market Value of Firm – (Book Value of Equity + Book Value of Debt) (Moyer, 2011).
From the information provided:
MVA of Astro Pharmaceutical Corporation = $53,000,000 - $500,000 - $500,000 =$52,000,000
What is the firm’s stock price?
The stock price per share is calculated through the use of the formula:
Stock Price = Market Value of Equity/Outstanding Shares
Using the information provided:
Stock Price of Astro Pharmaceutical Corporation = $52,500,000/$50,000 = $1,050
General Hospital
What is the value of the firm?
The value of the firm can be calculated through the use of the formula:
Value of the Firm = Free Cash Flow Year 1 / (WACC – Growth Rate)
From the information provided:
Value of General Hospital = 10,000,000*(1+4%)/ (20% - 4%) = $65,000,000
What is the market value of the firm’s equity?
We have not been provided any details regarding the market value of debt, the assumption is that the book value of debt will be the market value of debt. The formula of the market value of equity is as shown:
Market Value of General Hospital’s Equity = = $65,000,000 - $2,000,000 = $63,000,000
What is the firm’s MVA?
The MVA can be calculated through the use of the formula:
MVA = Market Value of Firm – (Book Value of Equity + Book Value of Debt)
From the information provided:
MVA of General Hospital = $65,000,000 - ($2,000,000 + $20,000,000) = $43,000,000
What is the firm’s stock price?
The stock price per share is calculated through the use of the formula:
Stock Price = Market Value of Equity/Outstanding Shares
Using the information provided:
Stock Price of General Hospital = 43,000,000/150,000 = $286.67
Part 3: How Warren Buffet might evaluate the proposed takeovers and which company he would prefer.
From the calculations and analysis done in the calculations above, the total value Astro Pharmaceutical Corporation is lower than that of the General Hospital. The proportion of debt based on book value for Astro pharmaceutical Corporation (50%) is higher than that of General Hospital (10%), this would indicate a higher financial risk due to the interest obligations (Schaltegger and Burritt, 2017). The best choice of action for Warren Buffet is to acquire General Hospital that has a higher value and has a lower proportion of debt. The answer is subjective and there could be other factors that need to be considered before making the final decision of the acquisition.
References
Deegan, C. (2013). Financial accounting theory . McGraw-Hill Education Australia.
Marchica, M. T., & Mura, R. (2010). Financial flexibility, investment ability, and firm value: evidence from firms with spare debt capacity. Financial management , 39 (4), 1339-1365.
Moyer, R. C., McGuigan, J., Rao, R., & Kretlow, W. (2011). Contemporary financial management . Nelson Education.
Schaltegger, S., & Burritt, R. (2017). Contemporary environmental accounting: issues, concepts and practice . Routledge.
